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Federal law provides Employee Retention Tax Credit for employers affected by California wildfires

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On February 9, 2018, President Donald Trump signed into law the Bipartisan Budget Act of 2018.1 Among other items, the law provides targeted tax relief to individuals and businesses impacted by the California wildfires. As part of this relief, an Employee Retention Tax Credit (ERTC) is created for companies that paid employees during a period of business inoperability resulting from damage incurred by the California wildfires.2 The ERTC is the same mechanism used to provide relief for businesses impacted by Hurricanes Harvey, Irma and Maria last year.3 The creation of the ERTC is important not only from a federal tax perspective, but for state and local tax practitioners who are often responsible for ensuring compliance with targeted federal tax credit regimes.

Employer Eligibility RequirementsThe ERTC is equal to 40 percent of qualified wages up to $6,000 for a maximum credit of $2,400 for each employee.4 The ability of a business to take the ERTC depends on the definitions of “eligible employer,” “eligible employee,” “qualified wages,” and the specific disaster zones determined by the president to warrant individual or individual and public assistance from the federal government under the Robert T. Stafford Disaster Relief and Emergency Assistance Act due to the California wildfires.5

   Eligible Employer

“Eligible employers” are employers with active trades or businesses on October 8, 2017, located in the California wildfire disaster zone, whose businesses were rendered “inoperable” on any day after October 8, 2017 until December 31, 2017 as a result of damage sustained by the wildfires.6

   Eligible Employee

An “eligible employee” includes any employee of an eligible employer whose principal place of employment on October 8, 2017 was in the California wildfire disaster zone.7

   Qualified Wages

“Qualified wages” include wages paid by eligible employers with respect to eligible employees on any day after October 8, 2017 until December 31, 2017, with one important limitation.8 The wages must have been paid between the period on which the trade or business became inoperable at the principal place of employment of the employee, and the date on which the trade or business resumed significant operations at the principal place of employment.9 Thus, any wages paid after the business resumes significant operations do not qualify for the ERTC.

   Disaster Zones

California wildfire disaster zones are specifically designated by the president under the Robert T. Stafford Disaster Relief and Emergency Assistance Act, a disaster relief law that originally was enacted in 1988.10 Under the Act, the President could expand eligibility for the California wildfire ERTC to other areas designated to be disaster zones through January 18, 2018.11 California wildfire disaster zones are listed on the Federal Emergency Management Agency (FEMA) and Internal Revenue Service (IRS) Web sites.12

Interplay with Work Opportunity Tax Credit (WOTC) A separate federal employment tax credit, the WOTC, is available to employers that hire individuals who are members of targeted groups such as qualified veterans, ex-felons, long-term unemployment recipients, or Temporary Assistance for Needy Families (TANF) recipients.13 Employers generally are eligible for a tax credit equal to 25 percent or 40 percent of a new employee’s first-year wages, up to the maximum for the employee’s target group. The maximum credit amount depends on wages paid to the employee, the employee’s target group, and the number of hours worked during the first year of employment. The various employee target groups have maximum credit amounts ranging from $1,200 to $9,600. If an employer is taking a WOTC on wages paid to an employee, the employer may not also take the ERTC on wages paid to the same employee.14 As a result, the wages for the WOTC must be segregated from the wages for the ERTC.

Potential State and Local Tax Impact There are several reasons why a federal tax credit like the ERTC may interest state and local tax practitioners. In our experience, state and local tax practitioners are often tasked with ensuring compliance with targeted federal tax credit regimes like the WOTC. With the enactment of the ERTC, state and local tax practitioners likely will face similar compliance challenges in determining the amount of the credit that might be available to aspects of their business that were affected by the wildfires.

In addition, interesting issues often arise at the state and local income tax level with respect to the deductibility of wages subject to the WOTC (and by extension, the ERTC). If a business utilizes the WOTC (as well as the Empowerment Zone or Indian Employment Credit), it is not allowed to claim the corresponding wages as a federal income tax deduction. Further, there is a fair level of inconsistency between states concerning whether disallowed wages are allowed for state income tax reporting. Some states follow the federal rule and disallow the deduction for those wages. In contrast, other states have specifically addressed this issue and allow wages associated with the federal credits to be subtracted on state income tax returns. In some cases, companies are allowed to subtract the wages associated with the WOTC but not the Empowerment Zone or Indian Employment Credit wages, or are limited to subtract only those wages for employees located in that particular state.

Commentary The ERTC is intended to provide relief to businesses affected by the recent wildfires throughout California. Similar to the ERTC as applied to provide relief to businesses impacted by Hurricanes Harvey, Irma and Maria last year, the IRS has not yet provided guidance on the definition of “inoperability.” The law requires that the businesses be inoperable “as a result of damage sustained by reason of” the disasters.15 According to guidance that the IRS provided for a similar credit intended for Midwestern businesses impacted by flooding in 2008, “[the] damage need not be to the employer’s place of business. For this purpose, a business is inoperable if, for example, because of the disaster, the business is physically inaccessible to employees, raw materials, utilities, or customers.”16

Furthermore, the new law does not provide any guidance on the meaning of “significant operations.” However, the IRS provided a definition for “significant operations” under the same 2008 guidance. As it relates to that credit, the IRS provided:

Whether a business has resumed significant operations is a facts and circumstances determination that takes into account the specific nature of the business. Consequently, there is no single answer for all trades or businesses. In making the determination, an employer should use a reasonable and good faith interpretation of what “significant” means in the context of his or her business. Generally, however, the term would not mean that the level of operations has met or exceeded the pre-hurricane level of operations.17

The lack of specific guidance by the IRS, coupled with potential ambiguity in the law, means the measurement and calculation of the credit must be reviewed using a facts and circumstances approach. For example, the closing and reopening of a retail establishment due to a wildfire may provide a portion of the potential benefits. Companies that reopened their stores but failed to have resumed “significant operations” due to inoperability or the inability of customers to reach the location may be able to consider alternative approaches to the duration of time the location is considered inoperable. Of course, to substantiate the amount of the ERTC, companies will need to collect and retain appropriate documentation, potentially including insurance claims and/or visual proof of the damage that resulted in inoperability.


 
1 P.L. 115-123.
2 P.L. 115-123, § 20103.
3 P.L. 115-63. For further information, see GT SALT Alert: Hurricane Relief Employee Retention Tax Relief Credit Provided for Employers.
4 P.L. 115-123, § 20103(a).
5 P.L. 115-123, §§ 20101(1); 20103(b).
6 P.L. 115-123, § 20103(b)(1).
7 P.L. 115-123, § 20103(b)(2).
8 P.L. 115-123, § 20103(b)(3).
9 The definition of qualified wages includes wages paid regardless of whether the employee works or not, performs work at places other than the principal place of employment, or performs work at the principal place of employment before significant operations have resumed. Id.
10 P L. 100-707. This Act provides the statutory authority for most federal disaster response activities.
11 P.L. 115-123, § 20101(2).
12 California Wildfires, FEMA, https://www.fema.gov/disaster/4344/designated-areas; Tax Relief for Victims of Wildfires in California, IRS, https://www.irs.gov/newsroom/tax-relief-for-victims-of-wildfires-in-california.
13 IRC § 51; U.S. Department of Labor, https://www.doleta.gov/business/incentives/opptax/benefits.cfm.
14 P.L. 115-123, § 20103(d).
15 P.L. 115-123, § 20103(b)(1)(B).
16 FAQs for Hurricane Victims—Employee Retention Credit, available at https://www.irs.gov/businesses/small-businesses-self-employed/faqs-for-hurricane-victims-employee-retention-credit.
17 Id.




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